Commodity Futures Trading Commission Open Meeting
Commodity Futures Trading Commission
Wednesday. July 22 – Thursday, July 23, 2020
Key Topics & Takeaways
- The CFTC approved the Final Rule on Capital Requirements of Swap Dealers and Major Swap Participants in a 3-2 vote.
- The CFTC approved the Final Rule on Cross-Border Application of the Registration Thresholds and Capital Requirements Applicable to Swap Dealers and Major Swap Participants in a 3-2 vote.
- In conjunction with the Commission’s approval of the Cross-Border rule, the CFTC’s Divisions of Swap Dealer Intermediary Oversight, Clearing and Risk, and Market Oversight withdrew a staff advisory and no-action relief regarding certain cross-border situations and issued new no-action relief.
- The CFTC unanimously approved an Amendment Order Exempting Certain Multilateral Trading Facilities and Organised Trading Facilities Authorized Within the European Union from the Requirement to Register with the Commodity Futures Trading Commission as Swap Execution Facilities
Open Meeting Day 1, Wednesday. July 22, 2020
Chairman Heath P. Tarbert
In his opening statement, Tarbert said that while much has changed in derivatives, including them being faster, increasingly digital, and more deeply connected to the global market, the one constant has been the absence of capital requirements for swap dealers, for which the Commodity Futures Trading Commission (CFTC) is responsible. He said the derivatives markets are vibrant due to the diversity of market participants and noted that the final capital rule applies to entities with a variety of business structures, asset profiles, and risk levels. Tarbert continued that a one-size-fits-all approach would not be compatible with the diversity in derivatives markets, therefore the margin rule provides flexibility by accounting for key differences among covered entities. He concluded that this flexible approach is designed to enhance the regulatory experience for market participants while safeguarding the markets.
Commissioner Brian D. Quintenz
In his opening statement, Quintenz said that the final rule is an adequate cushion to protect from losses, and the marketplace as a whole will have confidence that firms have a high probability of surviving the next crisis. He noted that the cost of capital is the biggest factor in a firm’s decision to maintain or become a swap dealer, and if capital costs are too expensive they will restrict firm activities or they will exit the swap dealer market, resulting in swaps markets becoming less diverse and less competitive. In order to achieve this, he explained that the Commission must commit to continually recalibrating rules as important as capital, as rules like this one provide the data to revisit these regulatory decisions.
Commissioner Rostin Behnam
In his opening statement, Behnam said that undercapitalization increases the impact of economic shocks. He noted that although multiple iterations of the capital rule have been proposed proposed, but this is the Commission’s first time voting on a final rule. He said that focusing resources and efforts on the institutions who pose the largest systemic risk leaves smaller entities, individually or in aggregate, still able to create significant risk. Behnam said that jurisdictions with the least regulatory oversight can directly impact the riskiness of the U.S. financial markets. He concluded that it is important to remember the lessons learned from the 2008 crisis, as the reforms that followed have shielded markets from the worst of the COVID-19 impacts and will continue to do so in the future.
Commissioner Dawn D. Stump
In her opening statement, Stump said that in order to achieve regulatory certainty it is important to also ascertain the cost of operating in this business. She noted that robust capital requirements increase the safety and soundness of the financial system, and balanced capital requirements lead to the prevention of unfavorable impacts on the market. She concluded that ongoing review and possible adjustments by the Commission and its successors is necessary, as flexibility in the rule is designed to ensure regulation can be adapted when necessary.
Commissioner Dan M. Berkovitz
In his opening statement, Berkovitz said that the CFTC’s regulations and implementation of requirements have resulted in stronger financial markets. He noted that this rule will not provide the protection Congress intended in Dodd-Frank, but instead will confirm the status quo or cut back on existing regulations. He explained that due to the pandemic, the derivatives markets are already experiencing volatility and price extremes, but so far despite volatility, the derivatives markets have continued to perform essential functions to help manage new risks. He said that the new rule makings of margin, cross border, and position limits will jeopardize progress, as they acquiesce to the industry’s request to roll back capital requirements, concluding that during the pandemic is no time to weaken regulation.
Final Rule: Capital Requirements of Swap Dealers and Major Swap Participants
- Joshua B. Sterling, Division of Swap Dealer and Intermediary Oversight (DSIO)
- Thomas J. Smith, DSIO
- Rafael Martinez, DSIO
- Joshua J. Beale, DSIO
- Jennifer Bauer, DSIO
Staff explained that the rule means to put markets on firmer footing for the future and put a final backstop in the swap dealer regime, saying the rule was built on three standards:
- Rigor – require real money, require robust capital levels.
- Certain – different measures to achieve the goal of having a backstop. Firms should have good understanding of capital requirements.
- Measureable – robust regime to assess swap dealer capital individually.
- Flexibility – yields a stronger capital standard. Many types of dealers can be slotted into multiple categories. Regulated bank entities, Broker-Dealers, FCMs, operating companies that conduct commercial businesses. This results in a single standard that uses different measures to accommodate different types of businesses.
- Perspective – requirements cover key points, registration and reporting, external conduct, compliance conduct, business conduct standards, uncleared margin requirements, and now capital. The standard is strong, but just the first step in creating and maintaining a robust capital regime.
Staff noted that these standards will need to evolve in the coming years and decades to ensure the capital rule will remain meaningful.
DSIO staff said they received 100 comments from varying types of organizations and they consulted with prudential regulators and the SEC during the writing process. Staff noted there are 155 provisionally registered swap dealers and of that, 56 are subject to the capital and margin rules of the Commission, while the remaining 52 are subject to a prudential regulator. The 56 provisionally regulated swap dealers represent a diverse group of firms, of which are four large broker-dealers dually registered with SEC. 24 represent foreign domiciled entities likely subject to existing comparable regulation, several remaining are non-bank subsidiaries of bank or standalone entities. Thus, staff concluded that the rule is flexible in design to leverage off already existing capital regimes.
Swap Dealers are offered the choice of one of three methods to calculate their capital:
- Bank- or Basel-based method – applies FRB rules to swap dealers as if the swap dealer itself is a bank holding company;
- Net liquid assets method – incorporates SEC rules to security-based swap dealers and is based on existing FCM and broker-dealers; or
- Tangible net worth method – swap dealers not engaged in financial activities.
Staff explained that the new rules also include a capital comparability determination process where foreign domiciled swap dealers can apply to the Commission for substituted compliance, subject to certain conditions. The rule requires swap dealers dually registered as FCMs must comply with FCMs net capital rules and several amendments made to reflect swap activities. The rule also incorporates recordkeeping and reporting requirements that are comparable to the existing requirements for FCMs and have harmonized to SEC requirements for security based swap dealers.
Staff outlined modifications to the 2016 proposed rule based on comments and data received:
- Adjustments have been made to the margin amount used in calculating capital minimums only on uncleared swaps. The margin amount multiplier has been adjusted from eight percent to two percent, but only for swap dealers selecting the net liquid asset approach. For swap dealers dually registered as FCMs, the two percent multiplier will be added on to the already existing margin multiplier in determining FCM capital requirements.
- Swap dealers selecting the bank-based approach will be required to hold regulatory capital.
- Eight percent of risk weight assets must be held in the form of common equity tier 1, additional tier 1, or tier 2. For purposes of this component:
- Six and a half percent of risk weighted assets must be in the form of common equity tier 1;
- Eight percent of uncleared margin must be held in common equity tier 1, additional tier 1, or tier 2 capital;
- Baseline floor amount of $20 million of common equity tier 1 capital;
- Amount determined by the Registered Futures Association
- For swap dealers electing the tangible net worth approach, commercial swap dealers will be permitted to apply the predominantly engaged in non-financial activities test at the parent level, but will be required to capitalize at the registered entity level.
Staff noted that each approach permits the use of internal models subject to approval by the Commission or to the NFA. Changes made to the model approval process include: permitting swap dealers to use, on a provisional basis, internal capital models approved by SEC, prudential regulator, or qualified foreign regulator approved for itself or an affiliate.
Commercial swap dealers electing the tangible net worth approach and MSPs can file quarterly unaudited financial reports instead of monthly financial reports. The timeframe to file annual audit statements is extended from 60-90 days. The final rules do not include a separate liquidity requirement, and there is no requirement for weekly margin position reporting. Staff recommend an October 6, 2021 compliance date, which gives swap dealers 14 months to come into compliance with requirements and is aligned with the SEC compliance dates for security-based swap dealers and major swap participants.
Chairman Tarbert asked DSIO staff to explain why they chose the two percent requirement for the net liquid asset approach rather than the eight percent for the other two approaches. Tom Smith of DSIO responded that under the net liquid asset approach, two percent is just the starting point. He continued there are adjustments made to the capital, including excluding all illiquid assets as well as any fixed assets, narrowing down to absolute liquid assets, as well as market risk charges to reduce the amount of capital compared to the risk margin amount. He said that one is based on tangible net worth based on total capital versus the net liquid asset approach, which uses a reduced balance sheet number, which is why the percentages were adjusted. Chairman Tarbert asked if DSIO could expand on the model approval process and NFA’s role. Smith responded that the Commission will ensure the NFA model approval process is consistent with the CFTC approach and will issue a letter to the public when the review of the NFA process is complete, so they are aware. He noted the focus will be on swap dealers that do not already have models approved by other regulators such as the SEC, prudential regulators, or a qualified foreign entity.
Quintenz asked DSIO if the net liquid asset and adjusted net capital is a more restrictive form of capital and if the market risk charges and credit risk changes change with market conditions, to deduct from capital and increase the risk margin amount. Smith agreed on both accounts. Quintenz noted that these charges could deduct a significant amount of net capital, up to 50-60 percent, and through these calculations can lead to a much-reduced amount of capital based on the framework selected. Finally, Quintenz asked, on net liquid asset and adjusted net cap approach, what were arguments for why proprietary cleared swaps were removed from the calculation of risk margin amount. Smith responded that they are accounted for, every position the swap dealer has is subject to capital charges, there is a minimum capital floor, and other charges are added onto that. He said cleared transactions are still subject to the market risk charges they present under the model and standardized approaches.
Behnam noted the CFTC has diverse market participants, making it unique, and noted that is why the three approaches are all necessary. He asked DSIO to characterize the three approaches and how they fit into business models. Smith responded, in recognition of the CFTC’s diverse group of swap dealers, they chose a bank-based approach and a traditional FCM approach to allow those different firms to be able to harmonize with SEC and prudential regulator capital rules they are already subject to. Smith also noted the CFTC has commercial entities registered as swap dealers who have different balance sheet structures and different assets that would not fit into other regimes. Behnam asked DSIO to explain how they landed at the two percent calculation. Smith noted they looked at the data received from previous proposals and that the two percent calculation would harmonize with the SEC’s approach. Benham asked about DSIO’s five year review period for the rule to which staff responded the review process will begin once they begin and will continue as they receive data from firms.
Stump asked DSIO to discuss the model approval process. DSIO staff noted a swap dealer would notify the Commission and the NFA that they have an existing model themselves or in their corporate family that has already been approved by the SEC or a prudential regulator that they plan to use. This will allow the NFA to focus on reviewing the remaining 12-14 swap dealers who will need internal model approval, as they do not have models approved by another regulator. The NFA will look at the approved models to make sure they meet the needs of CFTC rules on an ongoing basis, even past effective date. Staff said that determinations of substituted compliance for models will be addressed in an expeditious manner.
Berkovitz stated the cost benefit analysis in the appendix noted that in the bank-based approach, banks may be able to keep the same level of capital currently held and just reallocate the capital among their swap dealer subsidiaries, but that the entire bank or larger entity won’t necessarily be required to hold additional capital because of this rule. Director Sterling noted banking organizations are subject to existing capital standards and may have capital in excess of their requirements, thus they can meet the CFTC’s standard by reallocating capital to their swap dealer. Sterling also stated under the tangible net worth approach, the capital requirements would be new for those firms and they may need to raise additional capital.
Chairman Tarbert gave an analogy for each of the three approaches:
- Net liquid asset approach = cash in one’s wallet;
- Bank-based approach = cash in wallet + savings + retirement funds + other financial assets;
- Tangible approach = cash + retirement funds + house + car.
Quintenz noted that the substituted compliance framework allows the bank-based approach to use common equity tier 1 additional tier 1 and tier 2 capital, resulting in increased flexibility to meet all of the capital requirements, and asked if DSIO will monitor this requirement so that it doesn’t create competitive disparities. Director Sterling noted that they will be monitoring this.
Quintenz stated he believes this rule establishes minimum capital requirements that are sound and harmonize with the rules of the SEC. He said the rule is not perfect, but it can be revised or recalibrated in the future.
Quintenz said there are three areas not addressed in the final rule that he would like to see revisited:
- Standardized market risk charges for capital are rules too high and the Commission can work with the SEC to recalibrate and update charges to better reflect the risk;
- Modifying rules to recognize alternative forms of collateral such as letters of credits or leans when computing credit risk charges for commercial end users;
- Firms electing net liquid asset approach be required to maintain tentative net capital in excess of risk margin amount percent as opposed the current net capital requirement.
Behnam stated that the Commission should have issued a reproposal of the 2016 rule as the Commission could have received meaningful comments and specific data on a clearly stated reproposal which would have allowed the Commission to establish capitals standards appropriate to ensure end users are not penalized while also heeding congressional intent.
Stump stated she supports the finalization of the rule, saying now they can turn their attention to fine tuning requirements to ensure the end result is finally achieved.
Berkovitz summarized that the three approaches may not require additional capital to be raised by swap dealers, as it may be possible to keep the same level of capital but reallocate among entities. He expressed the need for data but recognized that getting data from swap dealers without requirements in place would not be optimal. He expressed the need to have balance between regulation without imposing unnecessary costs, but that the rule should have drawn the line in different places, as the Commission has a mandate from Congress that this rule does not meet.
The Commission approved the rule in a 3-2 vote, with Berkovitz and Behnam dissenting.
Proposed Rules: Margin requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
- Joshua B. Sterling, Division of Swap Dealer and Intermediary Oversight (DSIO)
- Warren Gorlick, DSIO
- Liliya Bozhanova, DSIO
- Carmen Moncada-Terry, DSIO
Prior to the staff presentation of the proposed rulemaking, Chairman Tarbert noted that the Commission would be voting on the described NPRMs in seriatim next week, rather than the open meeting.
Staff presented three proposed rulemakings with respect to the Commission’s Margin Requirements for Uncleared Swap Dealers and Major Swap Participants (UMR). The first proposed rule would amend the definition of material swaps exposure within CFTC regulation 23.151. Currently, 23.151 outlines the methodology for which financial end users will need to calculate their aggregate average notional amount (AANA). Section 23.151 currently sets forth that entities must calculate their AANA using the time period of June, July, and August of the prior year, while the BCBS-IOSCO framework recommends a time period of March, April, and May of the current year. The proposal would amend the material swaps exposure definition to align the calculation method with BCBS-IOSCO.
Second, the proposed rule would amend CFTC regulation 23.154(a) permit Covered Swap Entities (CSE) to use risk based model calculation of a Swap Dealer counterparty to determine the amount of IM to be collected. The proposal would be consistent with CFTC No Action Letter #19-29.
Third, the Commission will be proposing to permit the application of a minimum transfer amount of up to $50,000 for each separately managed account (SMA) of a legal entity, and separately, to recognize that separate MTAs can be applied for initial margin and variation margin. This proposed change would change would be consistent with CFTC No Action Letter #17-12 and #19-25.
Quintenz asked what type of entities would likely benefit from the proposed amendments to 23.154. Staff responded that it will likely be smaller swap dealers and end users. Quintenz then asked whether the proposed MTA changes would align with other jurisdictions. Staff responded that it would align the CFTC requirements with the EU’s MTA requirements.
Commissioner Stump stated that these proposals are clean up and would ensure better compliance. She added that she is not advocating for a roll back of the UMR that are currently applied, but rather these changes are being applied to a new set of financial end users. Finally, Stump recommended that the commission consider the GMAC report recommendations beyond what is currently being proposed.
Berkovitz asked staff whether the changes to the MSE definition would be consistent with BCBS-IOSCO and the prudential regulations within the U.S. Staff responded that it would be consistent with the BCBS-IOSCO recommendations, but it would diverge from the current standards set forth by the US Prudential regulators. However, staff did note that the prudential regulators had no objections to the CFTC amendments. Berkovitz then asked whether there are alternative safeguards in place to prevent market participants from evading the Commission’s MTA regulations by using SMAs. Staff noted that other Commission regulations, including the risk management requirements in Commission Regulation 23.600 would provide additional safeguards.
Open Meeting Day 2
Thursday, July 23, 2020
Chairman Heath P. Tarbert
Chairman Tarbert opened the meeting by emphasizing his belief that just because a final rule is less prescriptive than a proposed rule does not mean that the final rule is in itself deregulation. Further, he said he believes that the final rule is a justified deviation from the 2013 guidance given the deference granted to foreign regulators, and concerns with the CFTC’s extraterritorial jurisdiction. He noted that at the time of the cross-border guidance it was viewed by certain foreign regulators as very assertive, if not aggressive. In his view, he believes that by his predecessors issuing a guidance, rather than a rule, it infers they intended the Commission to revisit the rulemaking at a future date.
Commissioner Brian D. Quintenz
Quintenz began by stating that the finalization of the CFTC’s capital rule was a historic day. He noted that the rule was an important policy and the final rule was thoroughly vetted and calibrated. He criticized any suggestions that would call the rule deregulatory or a “rollback” and generally challenged comments made at the prior meeting’s discussion of the capital rule.
Commissioner Dawn D. Stump
Stump began by noting that the Commission is replacing guidance with binding, clear, and workable formal rules. Stump then provided some context of the cross-border rulemaking by discussing the advent of CEA Section 2(i) which was added by the Dodd Frank Act. Stump stated that a common sense reading of this section would limit the territorial reach of Dodd Frank requirements. She noted that the CFTC cannot infringe upon the rulesets of other nations. She stated that the final rule does not come from a blank canvas, but rather from a guidance in place for seven years that market participants have devoted countless time and resources to conform with. Stump noted the final rule codifies many elements from the guidance but incorporates many improvements.
Commissioner Dan M. Berkovitz
Berkovitz began by discussing why he believes this rule is in fact deregulatory, given it does not apply CFTC regulations to activities that are currently covered by the 2013 guidance. He believes it is appropriate and accurate to say it is deregulatory given it is no longer regulating certain activities and leaving it to someone else. On Section 2(i), Commissioner Berkovitz said he believes the interpretation set forth on the scope of 2(i) is essentially as broad as in the guidance, and he is pleased about that.
Final Rule: Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants
- Joshua B. Sterling, Division of Swap Dealer and Intermediary Oversight (DSIO)
- Frank Fisanich, DSIO
- Lauren Bennett, DSIO
- Rajal Patel, DSIO
- Jacob Chachkin, DSIO
- Owen Kopon, DSIO
Sterling began the staff presentation on the Commission’s final rule on the cross-border application for the registration thresholds and certain requirements applicable to swap dealers and major swap participants (“Cross-border rule”) by highlighting the rule’s effectiveness and practicality. Sterling noted the rule builds on the agency’s existing 2013 cross-border guidance, recognizing that firms worldwide have developed systems in order to comply with the Commission guidance. The rule, according to Sterling, is meant to be a fixed and certain standard that empowers swap dealers to achieve compliance based on what they’ve already done. It balances the Commission’s deployment of resources on cross-border activity and potential risks brought to the United states. Notably, Director Sterling stated that the Commission was not taking the approach of the 2013 Guidance with respect to non-US swap dealers that regularly use personnel or agents located in the US to arrange, negotiate, or execute a swap with a non-US person (“ANE Transactions”). Sterling concluded by stating that in the seven years since the 2013 guidance, the staff has not observed material gaps in the oversight of swaps marks and that the final rule is premised on the development of swaps regulations in most other foreign jurisdictions.
Patel then presented the specifics of the final rule, in particular the defined terms within the proposal. With respect to US Persons, Patel stated that the final rule’s definition is consistent with the definition adopted by the SEC in their cross-border margin rule. Next, Patel defined the key term Guarantee which, roughly, is an arrangement where one party to a swap has rights or recourse against its guarantor. Patel then described the new term in the final rule, the Significant Risk Subsidiary (“SRS”). Patel described the approach towards SRSs as a risk-based approach to determine which non-US based subsidiaries would be required to comply because they raise supervisory concerns due to their impact on the US financial systems. Patel walked through the specific terms that would classify an entity as an SRS and noted that the final rule would exclude two categories of entities that are already subject to significant regulatory oversight.
Following the discussion of defined terms, staff moved to the cross-border application of the swap dealer threshold and related grouped requirements. Staff presented a chart that mapped how the final rule would apply to swap dealers and certain counterparties based on entity status, and further described Group A, B, and C requirements which are applicable based on your registration status. Group A included requirements such as a CCO requirement, a risk management requirement, and a record keeping requirement. Group B included risk mitigation requirements relating to certain swap trading documentation and reconciliation procedures. Group C requirements include complying with the business conduct requirements and segregation of IM collateral. (Please note that this is not an exhaustive list). Finally, staff outlined certain exceptions from Group B and C requirements.
Finally, staff noted that in conjunction with the Commission’s approval of the final cross-border rule, the Divisions of Swap Dealer and Intermediary Oversight, Clearing and Risk, and Market Oversight withdrew a staff advisory and no-action relief regarding certain cross-border situations and issued a new no-action relief.
Chairman Tarbert kicked off the Q&A session with staff by explaining why he chose to support the final rule. Tarbert cited two main reasons for his support: first, because of the need for rule-based finality, given the 2013 guidance was taken outside of the rulemaking process. Second, he believes the rule is a better reflection of the congressional mandate. Tarbert noted that the final rule is a level-headed approach to extraterritorial application of the regime and is an acknowledgement of the role of the CFTC’s domestic and international counterparts relating to overseeing swaps markets. His decision, he noted, was guided by three principles. First, the CFTC needs to protect the national interest, and avoid poor use of taxpayer dollars to regulate everything with a nexus to the US. Second, if the CFTC needs to afford commodities to other regulators with comparable regulations. Thirdly, the CFTC needs to pursue harmonization with the SEC as appropriate. He believes that the approach taken for ANE Transactions is appropriately different from the SEC and supports the use of the SEC’s definition of a US Person.
Quintenz criticized the characterization of the final rule as de-regulation. Quintenz said he believes that the CFTC’s prior approach was an overreach and that the final rule is more consistent with congressional intent. Further, he noted that there is no need to duplicate regulatory efforts, whether it is domestic or foreign.
Behnam began by asking staff whether there was an expectation that the current number of swap dealers will be reduced or grow as a result of the final rule. Sterling responded that there is no expectation that there will be a significant change in the number of firms, registered or deregistered. Benham then asked staff to explain the rationale behind the $50 billion threshold. Staff responded that the $50 billion threshold has been used in other places, such as by FSOC, as well as in Dodd Frank. Staff noted that despite a departure from a $50 billion threshold in other regulations for more subjective tests, staff felt it was important to have a clear threshold to provide certainty for firms conducting assessment of their entities. Staff believes that the $50 billion threshold is an appropriate and conservative approach to seeing who would pose a risk to the US system.
Behnam then asked staff whether they considered narrowing how the guidance has interpreted Section 2(i). Sterling responded that staff gave Section 2(i) a great deal of consideration. In particular, staff took into account what it meant to have a significant connection to commerce in the US, given the size and general reach of the US economy. Sterling noted that staff had to think of things in terms of the relative size of the US economy as well as the comparability of other jurisdictions’ regulations. Benham then asked why staff felt it appropriate to pivot from the no-action relief and move forward with the final rule’s methodology with respect to ANE Transactions. Sterling noted that the ANE interpretation was not in the guidance, but came through subsequent staff interpretation. Further, he stated that after consultation with the CFTC’s Division of Enforcement, that even if the Commission’s rules are not applied the CFTC has many tools available in their anti-fraud provisions to go after bad actors within the US.
Stump asked approximately how many swap dealers are located outside of the US. Staff responded that roughly half of the registered swap dealers are located outside of the US. Stump then stated that those who have maintained that the final rule takes a narrow view towards the Commission’s extraterritorial approach should take note that half of the swap dealers registered in the US are located outside of the country. Stump further noted that as stated earlier in the meeting, the CFTC would not expect to see a significant increase or decrease of currently registered swap dealers if the Commission adopts the final rule.
Stump then discussed the definition of Significant Risk Subsidiary. Specifically, she noted that we need to be clear of the definition for those who have characterized that this definition of SRS inappropriately substitutes the oversight of the Fed or foreign regulators. Stump compared the definition of SRS to the conduit affiliate definition that was in the 2013 guidance. She noted that the conduit affiliate definition was not defined and was ambiguous. Further, Stump stated that there is no basis to conclude that the definition of SRS would lead to less robust oversight than the vague description of conduit affiliate. Hypothetical concerns are an insignificant basis to conclude the SRS definition is not good enough. Finally, on ANE Transactions, Stump stated that she believes that she does not believe the final rule’s approach is a retreat from the guidance. Stump stated that the guidance did not contain any provisions addressing ANE, and the Commission is not reversing something that had the endorsement of the Commission.
Berkovitz began his comments by stating that he wants to emphasize the 2013 guidance was issued fully in accordance with the Administrative Procedure Act. He noted the agency chose to proceed in a manner that would provide flexibility. He contrasted the request for clarity in the final rule to the request for flexibility in Reg AT.
Berkovitz focused the bulk of his first round of questions on what he felt was a potential workaround to the guarantee definition. Specifically, he asked staff to explain the concept of a back-to-back swap. Sterling explained it is when one entity enters into a trade, and as an affiliate, enters into an offsetting trade with another affiliate. Berkovitz then asked staff, with respect to the final rule’s definition of guarantee, if affiliates could use back-to-back swaps to transfer risks back to the US, and whether the US company’s executives would be aware. Sterling responded that the definition of guarantee is consistent with the definition in the CFTC’s cross-border margin rule, and that while he is unaware if executives would be aware of a risk transfer back to the US, there are some safeguards in place, such as the CFTC’s risk management program requirement, and general business judgment reasons, that would likely prevent this kind of rule circumvention. Berkovitz continued by noting his concerns with the final rule’s definition of guarantee and that it could be circumvented.
Berkovitz then noted his concern with utility of the SRS definition, given that the CFTC set up a category of entities to capture risks and subsequently set the threshold at a level where none would actually be captured. Sterling disagreed, noting that although staff did not conduct a full inventory of every company over $50 billion in the US, that this was more of a matter of deference.
Berkovtiz returned to the issue of back-to-back swaps citing a Citadel letter and Bank of England working paper that suggested certain firms could shift operations to foreign jurisdictions and use this strategy to shift risk back to the US. Sterling stated that he was aware of the Citadel letter but it does not address SEF trading and the migration of SEFs.
Chairman Tarbert asked staff if the guarantee definition harmonizes with the SEC with the clearing rules. Staff agreed that it does. The chairman made the point of having SRS, even if we do not think any exist today, is designed to prevent a foreign overseas version of Enron or AIG. The chairman then gave a list of hypotheticals to staff, highlighting that there are not gaps in CFTC oversight.
Quintenz acknowledged the statute that constrains the Commission’s ability to look at overseas activities, but said the rule appropriately interprets Congress’s directives. He continued that Congress placed a limit on CFTC extraterritorial reach, recognizing the need for deference as it prevents market fragmentation. Quintenz stated that ANE was dismissed by the court because the guidance was outside the application of APA and had a very insufficient cost benefit analysis. He noted DSIO staff will release no-action relief suspending ANE and looks forward to rules issued in the near future to finally dispense with ANE construct.
Behnam stated he believes the rule overlooks the Dodd-Frank act purposes and comments that raised concerns, opening a gaping hole in the federal structure. He noted the Commission cannot second guess Congress’s decision that Title VII applies extraterritorially. He expressed that the rule abdicates the Congressionally mandated responsibility to regulate activities outside of the US that meet jurisdictional requirements.
Stump expressed the need for updated definitions of guarantee, but she has no interest in departing from principles-based regulation and further noted that each rule adopted needs further analysis of regulation 2(i). She said that regulations imposing overlapping and duplicative requirements are inconsistent with Congress’s directions.
Berkovitz recognized that in previous rules harmonized with prudential regulators, such as the cross-border margin rule, there were two tests: guarantee and foreign subsidiary. He noted that for this rule, the foreign subsidiary test was dropped in place of SRS conduct, which is narrower. Berkovitz presented multiple scenarios to staff, noting that the US gives deference to other countries more than it should.
The Commission approved the rule in a 3-2 vote, with Commissioners Benham and Berkovitz dissenting.
Amendment Order: Exempting Certain Multilateral Trading Facilities and Organised Trading Facilities Authorized Within the European Union from the Requirement to Register with the Commodity Futures Trading Commission as Swap Execution Facilities
- Dorothy D. DeWitt, Division of Market Oversight
- Roger Smith, DMO
Staff explained that the amendment order under consideration is to exempt 16 additional multilateral trading facilities (MTFs) and organized trading facilities (OTFs) authorized in the EU and an amendment clarifying application of EU 5HC exemptive order to UK based MTFs and OTFs during the Brexit transition.
In December 2017, the Commission exempted 16 EU MTFs and OTFs from SEF registration requirements. In December 2018 four more were added. Since then DMO staff have engaged with colleagues in the EU on potential exemption of additional trading facility exemptions. The EU member states where these MTFs and OTFs are located provide reciprocal access to CFTC exchanges. Staff also recommended amendments to clarify the exemptive order will continue to apply to UK trading facilities during the Brexit transition. Staff also recommends two clerical changes: the home country in MTFs listed in the appendix, and to remove two EU trading facilities registered as SEFs that are exempt from SEF trading requirements.
Chairman Tarbert expressed agreement with the recommendations of staff. He said the EU is also working in good faith to build deference to the CFTC in their own rules. The Chairman said he looks forward to continued engagement with EU counterparts to curb fragmentation.
Commissioner Quintenz noted the order authorizes 16 TEFs to access the US market without complying with CFTC regulation or oversight. He said deference eliminates duplicative regulatory burdens and conserves resources while protecting market integrity.
Benham asked staff to explain what will happen to UK entities when the transition period ends at the end of this year. Roger Smith noted staff issued in April 2019 no action relief to MTFs and OTFs will continue to be covered by exemptive order while the CFTC staff works through a final determination on UK MTFs and OTFs.
Stump said that deference is almost too simple a word to describe all the work put in to get us where we are today and thanked staff for achieving the coordinated regulation that was intended in Dodd-Frank.
Berkovitz expressed support for comparability findings and noted this is an example of how international comparability is working. He asked if these facilities have to comply with CFTC reporting rules. Staff reported they have to comply with reporting requirements in part 43 and 45. The Commissioner also asked if post trade name give up applies and how they accommodate changes in US regulation in comparability determinations. Staff noted the EU does not have a ban on post trade name give up and that they look for comparable standards, not identical standards, however they do continue to evaluate rule changes made in the future.
The Commission approved the amendment order in a unanimous 5-0 vote.
Commissioner Dan M. Berkovitz
Berkovitz said he is proud of the agency’s commitment to advancing its mission, ad that although he disagrees with some of the recent Commission action, he recognizes the hard work of the staff in completing these two significant rulemakings during such a challenging time. He noted it is healthy for the public to see the Commissioners agree and disagree and this highlights the transparency within the agency.
Commissioner Dawn D. Stump
In her closing, Stump said it is a benefit to be able to work on five-person Commission with very different viewpoints, as it results in a better end product.
Commissioner Rostin Behnam
Behnam said he appreciates the work of the staff over the past few months and especially over the past few days. He expressed that CFTC rules are not stagnant, and the Commission should continue to be vigilant in observing the markets.
Commissioner Brian D. Quintenz
Quintenz thanked the entire staff for their hard work on the rules and thanked the Chairman and other Commissioners for the beneficial nature of their dialogue, which he said laid each Commissioner’s beliefs in plain view, which is the reason for the Sunshine Act and for these open meetings.
Chairman Heath P. Tarbert
Tarbert echoed his fellow Commissioners’ comments on the way they work together, saying that they may disagree but are not disagreeable. He continued that they are working together on difficult rules and come with differing views, but the Commission will not dodge tough issues. He said staff has been incredibly resilient in working on this through the pandemic. Tarbert said the Commission will not have another open meeting until September, but CFTC staff will be working to put the final rules in “good shape” to be sent to the Commission later this summer.
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